Pooling Money: The Future of Mutual Funds

The Future of Japan's Mutual Fund Industry

37 The Future of Japan’s Mutual Fund Industry 2 Compared with the markets in other countries, Japan’s market for mutual funds (which normally take the form of investment trusts) is small relative to the size of the national economy (figure 2-1). The fraction of household financial assets represented by mutual funds is increasing in both the United States and Germany, where it is now more than 10 percent, while it has been only about 2 to 4 percent in Japan. That is a sizable difference (figure 2-2). Factors in Recent Growth in Japan’s Mutual Fund Industry Although small relative to markets in other countries, Japan’s investment trust market began growing around 2003 (figure 2-3), probably owing to changes in market conditions, distribution channels, product innovation, and demographics. Market Conditions I begin by confirming the relationship between investment returns and the inflow of funds into investment trusts. Figure 2-4 shows the equity-deposit spread (return on equities minus the savings deposit interest rate) over time.1 As shown koichi iwai 1. Nakagawa and Katagiri (1999), which presents a detailed analysis of risk asset investment behavior in Japan’s household sector, uses the equity-deposit spread as a proxy variable for the return on risk assets. I follow that paper and run an empirical analysis using the equity-deposit spread as a proxy for mutual fund returns. 38 koichi iwai Percent United States 1970 1973 1976 1979 1982 1985 1988 1991 1994 1997 2000 2003 2 4 6 8 10 12 14 Germany Japan United Kingdom Figure 2-2. Mutual Funds as Percentage of Household Financial Assetsa Sources: Author’s calculations based on Flow of Funds Accounts (Federal Reserve Bank), Financial Accounts (Deutsche Bundesbank), National Statistics (Bank of England), and Flow of Funds (Bank of Japan). a. Figures for Japan are as of fiscal year end; all others are as of calendar year end. Percent United States France United Kingdom Japan Germany 10 20 30 40 50 60 70 80 Figure 2-1. Mutual Fund Net Assets as Percentage of Nominal GDPa Sources: Author’s calculations based on Investment Company Fact Book 2007 (Investment Company Institute ), National Economic Accounts (U.S. Department of Commerce), Annual National Accounts (French National Institute of Statistics and Economic Studies), United Kingdom National Accounts (Office for National Statistics), National Accounts (Deutsche Bundesbank), Long-Term Time-Series Data (Investment Trusts Association, Japan), and Quarterly Estimates of GDP (Cabinet Office, Japan). a. Figure for Japan is fund assets in March 2007 as percentage of 2006 nominal GDP. U.S. data are as of year-end 2006. France, U.K., and Germany data are as of year-end 2005. in figure 2-3, there was a large influx of funds into equity investment trusts in the late 1980s and again in the mid 2000s, periods during which total assets held in investment trusts grew and the equity-deposit spread remained high for several years. In the 1990s, however, there was an exodus of funds from equity investment trusts, and the equity-deposit spread remained largely negative during that period.2 The inflow of funds into investment trusts is strongly influenced by prevailing share price and interest rate trends. I attempt here to examine the quantitative impact that such market trends have on that inflow. As explained later, however, the popularity in Japan of funds that invest in foreign currency–denominated assets makes it essential to include the impact of currency rate fluctuations as a market factor (figure 2-5). I therefore estimate a vector autoregression (VAR) model with three variables: the equitydeposit spread, the month-on-month change in the nominal effective exchange rate, and the net inflow of funds into equity investment trusts.3 To evaluate the impact of the yen’s depreciation since 2003, I use two estimation periods. The the future of japan’s mutual fund industry 39 2. Funds flowed into money market funds and bond investment trusts in the late 1990s, with one likely reason being the relatively high rates of interest paid at the time. 3. After running the Phillips-Perron (PP) test on each variable, I found that the nominal effective exchange rate was a first-difference stationary process—I (1) process—and that the rest were level stationary Yen (trillions) 1980 1983 1986 1989 1992 1995 1998 2001 2004 Jan 2007 Apr 2007...